Why Venture Capitalists Love Foolish Startups

"You can generally separate new startups into two camps," says Hunter Walk, a partner at seed stage venture fund Homebrew, who previously worked for Google and served as a member of the founding team of Second Life.

"The first are opportunistic businesses, which are ones that tend to have a vision which is widely held and who are able to get there first. The reason they're able to get there first is usually some aspect of execution, or a key advantage in terms of talent distribution or capital—something that the other folks trying to do the same thing weren't able to achieve. In that case, one of the main advantages can be a level of expertise and familiarity with the space—having that non-naive knowledge of a sector, along with existing relationships with key employees, distributors, press, and customers."

Most entrepreneurs, Walk says, fall into this category. When it comes to the companies that really put a dent in the universe, however, naivety is a quality that many of the big names share.

"When you're talking about companies that change things—the Googles, Apples, and Teslas of the world—I think of them as belonging to an evangelical camp," Walk continues. "The founding team in that case hold a founding vision that isn't widely held, and may run counter to what we know about business. In this situation, the naivete—the lack of detailed awareness and understanding of why something can't be done—is actually very useful."

In some senses, naivete is the wrong word to use. Google, Apple and Tesla weren't founded by people naive about what they were setting out to create (although in the case of Google and arguably Apple they were naive about the business part of the equation), but they held views that were so new they struck other people as naive.

This naivete can help out in the long haul because it tends to favor a singular long-term vision rather than a short-term adherence to the conventions of business as they are today.

"One of the things Larry [Page] and Sergey [Brin] have been saying for years at Google is design your products as if bandwidth and storage were free," Walk says. "Now, of course they're not, but if you play out the laws of technology these are things which are cheaper each year. [Larry and Sergei aren't naive], but if you're trying to design forward-looking products, you shouldn't calculate your spreadsheet by working out how much a gigabyte of storage costs today—or how much it costs to stream a video file halfway around the world."

Provided that all companies want to be successful, why do some become shrewd opportunists, while others become naive evangelists? According to Walk (and others) it may have something to do with where these companies come from. The VC will most likely find a very different business proposition coming from the person already in a particular industry, versus the outsider looking to make a name for themselves.

"If someone hasn't worked in a particular industry, and doesn't have years and years of experience to show them what can't be done—or doesn't know what has been tried for years without success—that's where a lot of innovation comes from," says Peter Pham, cofounder and partner at Science, where he has helped build companies like Dollar Shave Club, DogVacay, Uncovet, Ellie, and Let's Date. "The people who are stuck living in the vertical that they're working in often find themselves unable to see the endemic issues in a particular field."

"Entrepreneurship means fighting against people who, by definition, benefit from the status quo," says John Lilly of Greylock Partners, a venture capitalist whose investment successes include Dropbox, Instagram, and Tumblr. "The idea that two people with a laptop can change the world is a crazy thought. In that sense it helps to go in with a fundamentally naive approach. If you knew everything that there was to know about a particular business you'd never try to do anything. It's much easier for people in my position, who have been around the block, to tell you an idea can't work than why an idea can."

In his work, business-management guru Clayton Christensen identifies two types of new technology: "sustaining" technologies, and "disruptive" innovations. A sustaining technology is something which supports or enhances the way a business or market already operates. A disruptive innovation, on the other hand, fundamentally changes the way that a particular sector functions. An example of the sustaining technology might be something like the advent of computerized accounting systems, while the digital camera (which famously led to the downfall of Kodak) represents the latter.

The "naive" entrepreneur might be more inclined to favor disruptive technologies, because they look at an industry with an outsider's objectivity and simplicity and try and imagine the way it "should" work. The opportunistic entrepreneur looks at the way it currently does work, and tries to work out how to capitalize on this.

But if there are (at least) two types of startup, then there are also multiple types of naivete.

"The disruptive startups I get excited about are the ones who do so with a degree of love, rather than the ones who do so with pure disdain and contempt," Hunter Walk says. John Lilly agrees with him. "The bad side of naivete are entrepreneurs who don't think they have anything to learn from anyone else," he says. "They take the approach that everyone else is a moron, rather than doing what they should be doing, which is asking a lot of questions and then working out whether the established norms work for them or not."

Another example of bad naivete might be a lack of awareness for the end user. Steve Jobs, for example, spent much of his career willfully playing the role of outsider. Even when Apple was a highly profitable company, he chose to expand into and explore new fields (music distribution, e-books, retail stores, television) in which he was still able to lay the role of upstart disruptor—despite having a multi-billion-dollar company behind him. But while Jobs embraced the idea of "[staying] hungry, [staying] foolish" he was anything but naive when it came to understanding user behavior.

Yet another type of negative naive behavior sometimes shown by founders is the kind of shorthand that suggests ideas haven't been properly considered. It's one thing to have an idea you're open to changing as it progresses; another to have a lack of vision behind what you're doing. Walk gives the example of the poorly-thought-through mashup, in which the pitch refers to "the Dropbox of x" or the "Github of y."

"It's a shorthand which sometimes suggests that they haven't expanded the idea, and that they're already viewing their work through somebody else's filter," he says. "Sometimes those can be warning signs of an idea that may not have anything behind it."

At the end of the day, naivete—like every other weapon in the would-be founder's toolkit—can have its pluses and minuses. Too much—or the wrong type—means a lack of realistic vision, and a refusal to learn from the world around you. Too little and you risk buying into the established vision of the world, and not being able to see far enough to change it.

"Good entrepreneurs will follow a particular vision in terms of instinct or gut reaction," says Peter Pham. "Great entrepreneurs follow the data. In many cases [with successful tech companies], you come in believing one assumption, only to have your users and customers come in, grab the product, and use it for something else entirely. That's a key difference."

Hunter Walk suggests that flexibility and naivety go hand in hand—and that they should stay this way. "I often think that anyone who won't embrace anything that's not 100% predetermined, and in which they know the whole plan from the very beginning, hasn't spent a lot of time in tech," he says.

Ultimately the difference between the foolish entrepreneur in the "stay hungry, stay foolish" sense and the straightforward fool is one that can be a fine line to tread—both for the would-be founder and the VC looking to invest in them.

No VC has a perfect hit record, and venture capitalists themselves must be willing to acknowledge that they don't know everything, and to buy into the right vision when it comes to investing. "It's not whether you believe an idea can work or not, but whether you believe that a particular entrepreneur is the one to carry it out," says Pham.

"I've had the opportunity to work with some amazing entrepreneurs—and when they say they can get something done, I don't question them at all. I love hearing amazing, crazy ideas—it's whether people can execute them that makes the difference between negative naivete, and brilliance."